Investors wonder who's in charge of Brazil's FX policy

RIO DE JANEIRO, Feb 1 When Brazil's central bank
intervened on Wednesday to halt a currency sell-off triggered by
comments from Finance Minister Guido Mantega, many investors
wondered who is really in charge of Brazil's foreign exchange
policy.

It was the second time in about two months that Mantega and
central bank chief Alexandre Tombini appeared to clash publicly
over the appropriate level for the real - a debate that has been
growing as Brazil's economic recovery has faltered and inflation
has stayed above target.

Both episodes, if not evidence of conflict among Brazilian
policymakers, are seen at the least as being an example of the
sort of seemingly contradictory policy action that has worried
investors and put a chill on Brazil's business climate.

On Wednesday, just one day after the real had
gained past 2 per dollar for the first time in seven months,
Mantega warned the government was ready to correct any "excess"
in the exchange rate and that a "speculative appreciation" of
the real would not be tolerated.

His comments brought the currency back to the 2-per-dollar
mark, but the change was erased minutes later when the central
bank announced it was rolling over $1.2 billion in dollar
repurchase agreements that would expire two days later.

When the real traded at around 2.10 per dollar on Nov. 23,
Mantega told a crowd of business leaders in Sao Paulo that the
exchange rate was at a "reasonable though not totally
satisfactory level" to support industry. He added that a real
weaker than 2 per dollar "was here to stay".

In moves similar to this week's action, the currency fell on
Mantega's comments only to be rescued minutes later by the
central bank, whose recent interventions are seen by analysts as
a sign of growing inflation concerns.

Like many analysts, Solot said it is tough to say whether
the central bank was deliberately offsetting Mantega's comments
or if the timing of its interventions was a mere coincidence.

Solot said, though, that it appears that Tombini is taking
the reins of Brazil's foreign exchange policy with the blessing
of President Dilma Rousseff, herself a trained economist who
likes to have a say in key economic decisions.

"My interpretation is that there are two different lines of
economic thinking (in the government). And the central bank's
thinking is gaining precedence over the finance ministry's
thinking," he said.

In Brasilia, a finance ministry source said there was no
conflict between Mantega's Wednesday speech and the central
bank's action. "There was no contradiction. The central bank
just did a (dollar line) rollover."

Citi strategists Kenneth Lam and Douglas Comin disagree.

"The central bank and the ministry of finance do not
necessarily see eye to eye on the issue of FX," they wrote in a
research note. "The central bank has won the battle of the day
in convincing the government to let the real appreciate to ease
inflation."

The central bank declined to comment.

IMPROVING COORDINATION?

Brazil's central bank and finance ministry had a long
history of disagreement over economic themes such as the right
level for interest rates and the currency during the eight years
of President Luiz Inacio Lula da Silva's government.

While Mantega was a voice in the chorus of discontent with
Brazil's double-digit interest rates, the central bank, led by
its former president Henrique Meirelles, carried out an orthodox
policy of high interest rates and a relatively free-floating
exchange rate to keep inflation at bay.

Under Rousseff and Tombini, however, the bank lowered the
base Selic rate to a record low of 7.25 percent while allowing
the real to devalue by nearly 30 percent in the period between
July 2011 and last November. Both actions were part of a
coordinated government action to boost economic activity.

But a persistent rise in inflation, combined with a still
anemic economic recovery, seems to have magnified lingering
tensions between the two institutions, with the central bank now
pushing for a stronger real.

To be sure, the finance ministry has also been unwinding
some of the measures taken early last year to curb dollar
inflows, helping the real gain about 7 percent in value since
the end of November.

On Wednesday, Mantega stressed that recent currency gains do
not mean the government is changing its foreign exchange policy
nor was it trying to use the exchange rate to curb inflation.

Instead, according to another source at the finance
ministry, a stronger real is part of a strategy to cheapen
imported capital goods and boost much-needed investment in
industry - an explanation that can certainly be more easily
digested by the exporters Mantega had pledged to protect with a
weaker currency.

Market analysts, however, are not totally convinced.

"The central bank wants the currency to help as a cushion
against inflation," said Bruno Eiras Martins, a trader at Banco
Daycoval in Sao Paulo.

"Some are saying that a stronger real is an instrument to
boost imports of capital goods and investment, but I'm not sure
about that. I believe that, given rising inflation concerns, the
central bank has adjusted its strategy."

While economists agree that a moderate currency appreciation
would not make a substantial dent on inflation, the fact that
the real pierced the mark of 2 per dollar earlier this week
should at least help anchor inflation expectations.

For now, most analysts agree, the central bank should offer
no resistance to a real as strong as 1.95 per dollar, as long as
the appreciation is gradual.

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